The "Robo-Signing" Settlement: Seeds of Recovery, Or Chaos?

George Mason law professor Todd J. Zywicki fears that the “robo-signing” agreement will lead to further efforts to bleed the banks, all the while delaying the necessary clearing of the housing market. The U.S. economy will be the potential victim of continued uncertainty.

After over a year of wrangling, last week the Obama Administration and 49 state attorneys general announced that they had reached a comprehensive settlement with five large mortgage servicers over claims related to their infamous “robo-signing” foreclosure practices.

The settlement provides $25 billion to state governments and homeowners in the form of principal reductions and cash payments, a figure that would rise if other banks sign on. In addition to imposing punishment and providing recompense for alleged past misbehaviors, the settlement provides much-needed relief and a path to recovery for a housing market paralyzed by the continued uncertainty concerning the ability of lenders to foreclose on nonperforming loans.

Or does it?

No sooner had the long-awaited settlement been announced than activists were beating the drum for more litigation, more penalties—and more uncertainty in the housing market. New York State Attorney General Eric Schneiderman called the settlement a “down payment” on compensating foreclosed homeowners and vowed to press for continued civil and criminal prosecutions.

Similarly, Janis Bowdler of the Latino civil rights group the National Council of La Raza characterized the settlement as merely the “first installment” of continued demands against the mortgage industry. In fact, while the settlement releases participating banks from conduct related to mortgage loan servicing, foreclosure preparation, and mortgage loan origination services, it permits further civil and criminal government prosecutions and piling on by class action lawyers.

Here regulators should be cautious about efforts to bleed still further dollars out of the banking industry through endless and protracted litigation. Some critics doubt whether the $25 billion settlement reached last week is sufficient punishment for the misdeeds of the banking industry. Others argue—perhaps with even greater justification—that the settlement provides an unjustified windfall to delinquent borrowers who suffered no actual harm as a result of the banks’ shoddy foreclosure practices, and homeowners who are underwater (those who owe more than their houses are worth) often times because of their own decisions to make minimal downpayments or to suck out home equity at the top of the housing bubble (Oklahoma’s Attorney General Scott Pruitt was the lone holdout among state AG’s, refusing to sign the deal because it favors defaulters over those who have paid their mortgages).

Moreover, the settlement provides new rules going forward to address common sources of legitimate consumer complaints, such as the practice of “multi tracking” modification and foreclosure procedures within a bank, inadequate foreclosure mitigation efforts, poor customer service, and the improper imposition of certain fees and requirements (such as “force-placed insurance” when the lender believes home insurance has lapsed). All of this reckoning and reform is important, of course, especially for those entangled in the foreclosure process.

For the rest of us who fortunately are not in foreclosure, however, the potential value of the settlement will be to lay the foundation for recovery of the housing market and, therefore, the economy at large. According to the research firm LPS Analytics, the average home in foreclosure has been delinquent for 674 days—a delay that has doubled since the exposure of the robo-signing scandal ground the foreclosure process to a halt. In Florida, the time from default to foreclosure now exceeds 1,000 days. During that time the homeowner can live rent-free—or even better, as news reports indicate that some of those in foreclosure will rent out the home to a tenant while the foreclosure is pending (sometimes resulting in a surprise to the unsuspecting tenant when the bank shows up to evict him).

Worse than the delay, however, is the uncertainty of a foreclosure system in chaos. Current occupants have no incentive to engage in a short-sale or otherwise turn the house over to a performing borrower. Buyers have no certainty as to when delinquent properties will finally come available for purchase. Billions of dollars of capital that could be recycled by lenders from liquidating foreclosed properties has instead been tied-up in dead loans with no possibility of repayment and uncertain timing prospects, thereby interfering with the ability of borrowers to obtain mortgages. Settling the claims will help break this logjam, enabling foreclosures to resume, the housing market to find a bottom, and the stock of lending capital to rebound.

But these benefits to the housing market and the economy will be dampened if some activists and attorneys general have their way and see the settlement as just a down payment on future assaults. To be sure, those who engaged in fraud and shady conduct should be prosecuted for their misdeeds.

But mere pursuit of newspaper headlines by politically-ambitious politicians or financial windfalls for borrowers who suffered no tangible harm should not come at the expense of the rest of us and the economy at large. It may feel like justice when banks are forced to pay out billions of dollars to deadbeat homeowners, but that money has to come from somewhere—typically the rest of us, who face higher bank fees and reduced access to credit as a result. In turn, this will continue to stifle a housing market recovery and exert a drag on the economy.

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